When faced with a sudden emergency expense, such as a medical bill or car repair, don’t let guilt over dipping into your household savings tempt you into using a credit card instead.
According to a forthcoming study in the Journal of Marketing Research, many misguidedly choose credit to pay for unexpected expenses instead of tapping their liquid savings and wind up paying more as a result.
“People commonly take on additional debt to avoid drawing down savings,” write study authors Abigail B. Sussman and Rourke L. O’Brien in an early version of the report. For example, previous research found roughly 33 percent of consumers with credit card debt have at least a month’s worth of income saved up in an easily accessible account. Meanwhile, around 20 percent of consumers who recently took out a high-interest small dollar loan, such as a payday loan, still had access to some savings.
“Given the large difference in interest rates (savings accounts yielding 1 to 2 percent interest and credit card charges averaging over 16 percent in the period described above), this behavior can be financially costly,” write Sussman and O’Brien. Despite the bigger expense, many people mistakenly believe using a credit card to pay for an emergency is more responsible than using cash they’ve saved for something else.
If savings are earmarked for an important and emotionally charged expense, consumers are even more likely to take on unnecessary debt, the study found. “People’s sense of personal responsibility and feelings of guilt can affect their financial decisions – and not in a good way,” write the authors in a news release. “If the money they have in savings is set aside for something they think is important to their sense of self-worth – say, their child’s education – they will leave those savings untouched.”
The authors came to their conclusions after conducting a series of experiments testing how people responded to unexpected expenses. After measuring their reactions to a series of hypothetical scenarios, the study found guilt often played a major role in prompting people to turn to plastic instead of cash. For example, people were significantly more likely to use credit if their available savings were earmarked for a “responsible purpose,” such as saving for their kids or home repairs, rather than something more frivolous, such as a beach vacation.
“By earmarking money toward highly valued goals, households appear to be making these dollars sacred, insofar as they are willing to incur costs to protect their earmarked status,” write Sussman and O’Brien.
That can be a good strategy if you’re trying to avoid making too many impulse purchases. When money is set aside for a special purpose, the less likely you are to spend it. The problem is if you become too rigid with savings and refuse to spend cash on unexpected expenses, you could potentially undermine your progress by taking on unnecessary high-interest debt.